WHO SHOULD BE GIVEN MORE FOREIGN AID?

This paper presents a simple model to investigate the effectiveness of foreign aid. It shows that foreign aid is most effective if it is given to a market economy with relatively high transaction efficiency. If transaction efficiency in a market economy is low due to, for instance, bad institutions or policies, then foreign aid will either be largely dissipated as transaction costs or can even lead to retrogression of market activities. In either case, it will be more effective to give foreign aid to poor primitive economies with no developed markets.